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July 10 (The following statement was released by the rating agency)
Fitch Ratings says that protracted recession in the
eurozone, coupled with a reversal in global risk appetite for emerging market
(EM) assets in Q213 following US Federal Reserve (US Fed) comments on an exit
from quantitative easing (QE), have taken the edge off of economic recovery in
Emerging Europe, including Russia and Turkey. Even so, the majority of sovereign
ratings in the region remained on Stable Outlook at end-June, with two (Poland
and Latvia) on Positive and four (Croatia, Slovenia, Serbia and Ukraine) on
Negative. Positive rating actions in H113 were confined to Lithuania and Poland,
while Slovenia and Ukraine sustained negative actions.
With the eurozone set to register a further contraction of 0.6% in 2013, growth
in Emerging Europe is expected to slow for the second year in succession to 2.3%
in 2013 from 2.5% in 2012, with some countries (Croatia and Slovenia) sustaining
outright contraction. In Slovenia's case, this has been overlaid by the rising
cost of recapitalising the banks; Fitch downgraded Slovenia to 'BBB+'/Negative
from 'A-'/Negative in May.
The downturn in the eurozone has coincided with limited room for domestic policy
manoeuvre in Emerging Europe. Fiscal policy is set to remain contractionary,
weighing on growth. Poland and the Czech Republic are still constrained by the
EU's Excessive Deficit Procedure (EDP), while Bulgaria, Hungary and Romania will
be anxious to preserve their EDP-free status. Russia's new fiscal rule maps out
a path of gradual fiscal tightening until 2015, although ambitions to rebuild
the Reserve Fund as a fiscal buffer have recently been scaled back. Turkey looks
to have more room for fiscal stimulus, but Fitch expects heightened political
unrest and deteriorating market sentiment to constrain its room for manoeuvre.
Ample global liquidity, shrinking current account deficits and low inflation
allowed a number of countries in Emerging Europe to cut interest rates in H113.
(Russia kept benchmark rates stable, but there are widespread expectations of
policy easing in H213.) A surge in net capital inflows from H212, mostly
portfolio investment in Eurobonds and non-resident holdings of local currency
debt, not wholly related to fundamentals, had begun to breed complacency in some
cases. Thus, Hungary and Ukraine had both taken a step back from concluding new
deals with the IMF in the belief that heavy repayment obligations to the Fund in
2013-14 could be funded in the market.
An early casualty of the shift in market sentiment has been Ukraine where Fitch
revised the Outlooks on its 'B' ratings to Negative from Stable on 28 June, to
reflect an increasingly challenging external financing position. Hungary
demonstrated a remarkable ability to substitute domestic for external financing
in 2012; nonetheless, its fiscal financing requirement remains large and the
forint is vulnerable to shifts in market sentiment in the absence of a fresh
EU-IMF agreement. Romania, too, suffers from large foreign exchange exposures at
the sovereign, corporate and household levels. However, it is making faster
progress with reforms and seems more amenable to a new IMF agreement.
Turkey presents more of a conundrum. Increased expectations of a US Fed exit
from QE coupled with widespread anti-government protests since April have
exposed the country's chief vulnerability: a current account deficit equivalent
to 6.8% of GDP, over 90% of which is funded by portfolio investors. Turkish
asset prices have come under strong downward pressure, precipitating a sharp
fall in the exchange rate and declining international reserves. Fitch elevated
Turkey to investment grade in November 2012 and considers that these strains
remain within the tolerance of its 'BBB-' rating. However, prolonged social
unrest, poorly handled, could deter tourism, exacerbate short-term capital
outflows, drive-up inflation and damage economic growth, potentially putting
Turkey's sovereign rating at risk.
Poland and Czech Republic appear much more secure, notwithstanding less
resilient growth in the former and continuing recession and increased political
instability in the latter. Fiscal funding needs are well covered in both, while
Poland enjoys the additional comfort of an IMF Flexible Credit Line. Russia,
with its strong sovereign balance sheet, is also relatively immune to shifts in
market sentiment, although Russian corporates and banks have been heavy issuers
on the Eurobond market. However, growth slowed to less than 2% year-on-year in
Q113 and it remains unclear how the economy will fare in the face of flat oil
prices and only cosmetic improvements at best in the investment climate.
Fitch says that Emerging Europe has not been without its success stories. Thus
the Baltics (Estonia, Latvia and Lithuania) continue to buck the broader
austerity-bound economic outlook, posting some of the highest growth rates in
the region. Latvia recently followed in the footsteps of Estonia, gaining the
green light to formal eurozone membership from 1st January 2014, with Lithuania
expected to follow suit in January 2015. Fitch upgraded Latvia's sovereign
ratings to 'BBB+'/Stable from 'BBB'/Positive on 9 July in recognition of the
culmination of this long sought after policy goal.
The same cannot be said of Croatia and Serbia. A common theme running through
these countries has been a deteriorating macroeconomic and fiscal outlook,
coupled with a reluctance to undertake structural reforms. Fiscal financing does
not pose immediate concerns, but public debt/GDP ratios continue to rise.
Croatia ('BBB-'/Negative) lacks a medium term fiscal consolidation programme and
there is a risk that longstanding structural shortcomings will overshadow its
recent admission to the EU. Serbia ('BB-'/Negative) suffers from twin fiscal and
current account deficits; the latter shows signs of rebalancing, while the
economy has emerged from recession, but the government has been slow to address
fiscal imbalances and public debt/GDP could rise to 70% by 2015.
In sum, in most cases, Emerging Europe is expected to prove resilient to renewed
turbulence in world financial markets. However, the region still bears the scars
of the 2008-09 global financial crisis which, together with some country
specific factors, are expected to temper governments' policy responses and slow